ESG Litigation: An Opportunity for AI-Powered Risk Prevention 

Katrina Hung
AI Research Analyst

Attention toward Environmental, Social, and Governance (ESG) initiatives have grown substantially in the past few years. More than 95% of the Fortune 50 companies currently include some ESG disclosures in their SEC filings. Increasing concerns over the impacts of climate change and social inequality have seen a stronger emphasis on different stakeholders’ interests and the imperative to "build back better" after the pandemic. 

Both push and pull factors underline the need to re-evaluate a company's ESG risk management strategies. On the one hand, investors and regulators increasingly consider ESG ratings as part of company performance. Notable organisations, such as Moody's have developed scoring metrics to grade companies on their ESG performance. At the same time, the over-arching nature of ESG reaches a broader class of stakeholders that are affected by issues of corporate governance, environmental sustainability, and social equality.

Increased attention on ESG presents both challenges and opportunities for companies. While ESG undertakings allow companies to distinguish themselves from their competitors, these commitments also increase litigation risk. Particularly, ESG litigation matters can impact the heart of a company's reputation. Damage can also indirectly stem from the time and level of management attention required to manage such disputes. These consequences can significantly affect a company's reputation, relationships with investors, employees, customers, and other valuable stakeholders.

This case study will: 

1. Analyse changing attitudes from regulators and stakeholders towards ESG
2. Detail the common types of ESG litigation and their impact on companies
3. Address the need for companies to enhance enterprise risk management using AI to achieve more holistic, proactive risk monitoring.

Categories of ESG-related disputes

ESG initiatives address a broad range of matters that can create a range of new litigation risks. Examples include:

1. Environmental issues, including the preservation of biodiversity and natural resources;
2. Social issues, including working conditions, workers' rights, and workplace diversity;
3. Governance issues, including management between parent and subsidiary companies

The most pertinent causes of ESG-related litigation observed by practitioners thus far relate to:

1. Company governance and operations;
2. Company disclosure and reporting;
3. Tort claims directed towards board directors for breach of fiduciary duties

Large multinationals continue to be the targets for ESG-related litigation. Notably, claims are increasingly directed at the level of parent companies or individual directors, which challenges the conventional approach to corporate legal personality. There is a demand for enhanced oversight of ESG risks across different departments of an organization.

Litigation associated with company operations and governance

This category of claims includes allegations of unfair and deceptive business practices, exaggerations of ESG accomplishments such as greenwashing, and misrepresentation regarding sustainability.

Of particular interest is a change towards holding parent companies liable for the activities of their subsidiaries. In Lungowe and others v Vedanta Resources plc and another, the claimants brought a claim of negligence against an English parent mining company for its Zambian subsidiary. The claimants alleged personal injury and damage to property, among other claims, due to discharges from a mine owned and operated by the subsidiary. Similarly, in Okpabi and others v Royal Dutch Shell plc and another, claimants sought to attribute the liability of pipeline oil leaks operated by a subsidiary against the parent company. A common argument is that large multinational companies have group Environment, Health and Safety (EHS) policies akin to assuming oversight over their subsidiaries.

Claims relating to deceptive business practices and misrepresentation have also increased. In July 2021, Oatly, one of the world's largest plant-based milk companies and its directors faced a class action from its shareholders. The claim alleged that Oatly's statements about greenhouse gas emissions and energy consumption associated with its product had been misleading. Similarly, in 2020, a class action was filed against Procter & Gamble, which alleged that the marketing of 'plant based' laundry detergent had been false because the product included petroleum-derived ingredients. These claims should alarm companies that label products with environmental friendly claims.

Litigation associated with disclosure and reporting  

In 2018, Exxon Mobil faced proceedings from the New York state's Attorney General, which alleged that the company had misled investors about the impact of climate change regulation on its business. The Attorney General argued that Exxon had based business decisions on an understated cost of carbon, which made Exxon's assets appear more secure and valuable than they were. Similarly, in Ruiz et al v. Darigold, Inc, the claimants highlighted their reliance on the company's Social Responsibility Report, which the company admitted were false.

These developments show that regulators are increasing attention to ESG claims, specifically concerning disclosure and environmental matters. The US Securities and Exchange Commission recently started consultations for a proposed rule that requires public companies to make specific climate change-related disclosures. Comparably, the UK government also announced intentions to introduce new supply chain due-diligence obligations that address deforestation through the Environment Bill.

Litigation associated with breaches of directors’ fiduciary duties

Conventionally, shareholders have difficulty pursuing claims based on inadequate oversight by company directors. Marchand v. Barnhill, however, marks a change in changing judicial attitudes. The Delaware Supreme Court judged in favour of claimants in a shareholder derivative suit that alleged that company board members breached the duty of loyalty by failing to exercise proper oversight. As a result of a listeria outbreak at a manufacturing plant that caused the death of three workers, product recalls, and employee dismissals. The claimant alleged that the company's board had failed to implement any systems to monitor the company's food safety performance. The court found that the directors had breached their duty of loyalty to exercise oversight, obtain reasonable information, and monitor the company's legal compliance. 

Across industries, directors of large companies, including Qualcomm and Oracle have also been implicated by shareholder derivative lawsuits, which involved allegations of breaches of the duty of care and loyalty due to insufficient commitment to diversity at the board level. Although many of these cases are ongoing, it signifies a judicial attitude that is increasingly stakeholder friendly.

Prevent and mitigate ESG risks with AI

A growing range of ESG-related claims and an ongoing focus from regulators highlight the need for companies to proactively adopt risk prevention and mitigation measures. Companies and investors are increasingly leveraging AI to understand relevant data more intelligently, allowing for better bench-marking, goal setting, and performance evaluation.  AI has the potential to facilitate ongoing risk monitoring to ensure that companies can uphold their ESG commitments to stakeholders.

Significantly, AI can help organisations maintain their ESG undertakings as operations scale across different jurisdictions jurisdictions. Taken together, adopting a technology-driven approach to ESG risk management can enhance operational resilience. The primary objective is to ensure that companies have the necessary infrastructure, both at parent and subsidiary levels, to comply with ESG-related regulation and policies.

AI tools like Deriskly can help to prevent and mitigate ESG-litigation risks through improving company board oversight, enhancing ESG data collection analysis, and preventing ‘greenwashing’ which has resulted in a rising number of  lawsuits.

Enhance company board oversight

Empowering company boards to act as the "lead body with the responsibility of guiding the company to success" has been highlighted by the Senior Advisor of the World Business Council of Sustainable Development (WBCSD) as the key priority to addressing ESG-related disputes. Given the potential financial and reputational damage to a company flowing from an ESG lawsuit, the board must have real-time insights into relevant risks arising from parent and subsidiary companies’ activities so that it can provide appropriate guidance and oversight. 

Tools like Deriskly that deploy advanced Natural language processing (NLP) can be particularly useful in this context. Deriskly can extract and categorise available structured and unstructured data from various sources, including emails, documents, social media, and websites – in real time. Additionally, Deriskly’s analysis can capture sentimental, contextual and semantic factors embedded in the text, which forms part of its proprietary risk assessment tool. This real-time risk assessment can inform the board of potential ESG-related disputes early on (when such risks first emerge), therefore enabling the board to make time-critical, data-driven decisions to prevent or mitigate relevant risks.

Enhance data collection and analysis for ESG reporting

In collecting the necessary data for ESG reporting, manual search continues to be the norm for many companies. However, given the diverse range of relevant data sources (which are often siloed) and the large volumes of data involved, manual processes have proven to be particularly burdensome. Importantly, manual processes can often encounter problems of incompleteness or errors in identifying a comprehensive range of relevant data points.

Whilst quantitative data analysis is usually readily available, practical analysis of vast amounts of qualitative data from diverse sources has been recently enabled by NLP-driven tools. Qualitative analysis can be particularly valuable for companies to highlight and substantiate tangible demonstrations within the social and governance pillars of an ESG report, which includes topics such as business ethics and social opportunity.

Prevent risks of “greenwashing”

Companies including Tender Corp and Dyna-E have been challenged under the Federal Trade Commission (FTC) Act for greenwashing statements in the US. The FTC Act prohibits "unfair or deceptive acts or practices" by companies, which has allegedly been breached by the companies' claim for "biodegradable" products.

To prevent greenwashing, a company should foster transparency regarding its ESG performance, particularly in verifying and substantiating all relevant communications to its stakeholders and the public. As mentioned above, an AI-powered tool like Deriskly can be used to enhance the collection and analysis of diverse ESG data, thus providing a company with a much more accurate picture of its performance. Deriskly can help to identify risks of ‘greenwashing’ where there are inconsistencies and contradictions between a company’s ESG reports and communications on the one hand and external data on the other – thus preventing misreporting.


Conclusion

In this changing landscape, using AI to monitor ESG-related risks can equip companies to better identify, assess and resolve potential disputes with a wide range of stakeholders. As corporate sustainability reporting obligations become increasingly regulated, AI-powered tools like Deriskly offer valuable assistance for companies to enhance corporate governance, demonstrate ESG undertakings credibly, and prevent potential “greenwashing”.